In mid-December 2017, Finance Minister Bill Morneau announced the long-awaited details of changes to the Income Tax Act. As of January 1, 2018, these changes impact incorporated individuals who use income sprinkling to reduce their tax burden by dividing profits among their family members who may see that income taxed at a lower rate[1].
Previously, adult shareholders (18 or older) were permitted to receive dividends from private corporations regardless of their involvement in the business. This allowed business owners to split income with spouses, adult children, parents, or other adults so long as they were 18 and over and held shares of the corporation. This approach was widely used to split income with individuals in lower tax brackets, thereby reducing the overall tax cost of getting funds out of corporations.
On the other hand, minors (under the age of 18) could not receive dividends from family-owned businesses without punitive taxes (TOSI – Tax On Split Income). If minors had received dividends from a family-owned business, they would pay taxes at the highest marginal tax rate and would be denied access to personal tax credits in respect to that income.
As of January 2018, the proposed legislation expanded TOSI to include dividends received by adult family members subject to a reasonability test. Automatic exclusions to this reasonability test exist for individual members of a business owner’s family who fall into any of the following categories:
- The business owner’s spouse, provided that the owner meaningfully contributed to the business and is aged 65 or over. In recognition of the special challenges associated with planning for retirement and managing retirement income, the new approach to income sprinkling will be better aligned with the existing pension income splitting rules. This also reflects the fact that a business can play an important part in supporting its owner in retirement.
- Adults aged 18 or over who have made a substantial labour contribution (generally an average of at least 20 hours per week) to the business during the year, or during any five previous years. For businesses with seasonal operations, such as may be the case with farms and fisheries, the labour contribution requirement will be applied for the part of the year in which the business operates.
- Adults aged 25 or over who own 10 per cent or more of a corporation (votes and value) that earns less than 90 per cent of its income from the provision of services and is not a professional corporation.
- Individuals who receive capital gains from qualified small business corporation shares and qualified farm or fishing property, if they would not be subject to the highest marginal tax rate on the gains under existing rules.
Individuals aged 25 or over who do not meet any of the exclusions described above would be subject to a reasonableness test to determine how much income, if any, would be subject to the highest marginal tax rate. In certain cases, adults aged 18 to 24 who have contributed to a family business with their own capital will be able to use the reasonableness test on the related income.
What does this all mean for a medicine professional corporation? In a nutshell, only two exclusions can apply:
- Unless shareholders such as your spouse, adult children, or parents are contributing to your business in a substantial way (defined as a minimum of 20 hours per week), they should not receive dividends from your corporation.
- If the incorporated physician is 65 years of age or older, they can split corporate income with a spouse (even if the spouse is not 65 years of age).
If a physician does not fit in one of these two categories, they might still have the option of paying a reasonable salary to another individual if they work for the corporation (this should only be done in consultation with your tax professional). Most incorporated professionals that would in the past have been able to split income with other shareholders in lower tax brackets will likely see their personal taxes go up in 2018.
Another planning strategy to consider would be spreading larger personal costs over multiple years. This includes paying down debt too aggressively. There could be a greater opportunity to minimize taxes and spread the repayment of debt over multiple years.
This change has dramatically impacted physicians’ ability to save for their children’s education. We would welcome you to read our article Funding your child’s education through your corporation is no longer an option: Reconsider RESPs
If you would like a second opinion as to whether your wealth plan is ideally situated with these changes in mind, please contact Tall Oak Private Wealth
[1] Scotti, Monique, Global News, “What you need to know about Morneau’s changes to ‘income sprinkling’ rules,” Dec. 13, 2017. Accessed January 25, 2018 at: https://globalnews.ca/news/3914672/bill-morneau-changes-tax-proposals-small-business/
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